DIY Investor Magazine
|
June 2017
7
So for investors looking for regular income, there are
drawbacks to putting their money in shares.
THE POWER TO PAY MORE THAN “PAPER
PROFITS”
Some years ago, investment trust companies were not
allowed to pay dividends to their shareholders out of the
capital gains from increases in the market value of the
investments they held. But in 2012, this restriction was
removed. This means that as long as investment trusts
have amended their articles of association to allow this
change, they now have the power to pay dividends
out of the capital gains on their investments, as well as
from the dividends or interest that the investments earn.
Dividends payable from a combination of profits and
capital gains on investment are known as enhanced
dividends. If company profits and stock markets are
buoyant, enhanced dividends can provide a relatively
high income each year.
Enhanced dividends can be particularly attractive to
certain types of investors who want to receive a regular
annual income but at the same time maintain (or even
increase) the capital value of their investments.
Other investors also look to invest in shares that pay
high dividends, because dividends payments are
tangible investment return, whereas longer-term capital
gains are more uncertain and may turn out to be illusory
if unrealised gains (or ‘paper profits’) recede before
being taken. The potential benefits of investing in
shares of investment trust companies in order to receive
enhanced dividends offer clear advantages to income
investors, with the actual amount of dividend payments
depending on the performance of the shares that the
investment trust holds.
BALANCING SHORT- AND LONG-TERM
OBJECTIVES
When it comes to investing, there’s no such thing as
a free lunch. And what’s good for income investors is
unlikely to be as good for long-term investors. Long-term
investors want a healthy return from capital gains, rather
than big dividends on their investments: that’s because
if an investment trust pays enhanced dividends out of
capital reserves, the potential for longer-term capital
appreciation is lower.
So what’s the answer? Investment trusts therefore need
to balance the shorter-term objective of adopting an
enhanced dividend policy to pay higher dividends with
the need to protect shareholder interests and capital
value over the longer term.
THE POWER TO DELIVER INCOME AND GROWTH
Despite these challenges, a policy of paying enhanced
dividends can make it possible for investment trust
companies to satisfy investors’ needs for dividend
income today and also some capital gain tomorrow.
They can invest in the shares of companies with strong
prospects for growth and capital gain, without having
to ‘chase yield’ and invest in high-dividend companies,
because they can pay dividends out of the capital gains
that their investments enjoy.
Of course, there’s a risk that investment trusts might
pay out too much in dividends and so reduce their
capital reserves to a point where future prospects are
damaged. This is why the boards of investment trust
companies regularly review their enhanced dividend
policy, and the size of their dividend pay-outs, to ensure
that they remain prudent and affordable.
MOVING FROM POLICY TO PRACTICE
The devil is in the detail: the rules permitting enhanced
dividends have been in place since 2012, but not
all investment trust companies have changed their
articles of association (for which shareholder approval
is required) to permit enhanced dividend payments.
Meanwhile, some may have changed their articles
of association, but may not yet have progressed to
adoption of an enhanced dividend policy.
For income-seeking investors, this innovation in the
trust space is timely – investing in cash, or directly
in dividend paying shares, is not without drawbacks.
Investing to achieve enhanced dividends could well
represent an attractive alternative option.
